On 14 May 2012, the Economic and Monetary Affairs Committee of the European Parliament voted on a proposal to cap variable pay at 1x salary. As defined, variable pay include bonuses and long term incentive plan awards. The legislation is to be voted on by the EU Parliament on 21st November 2012. If it’s passed, it is likely to have a significant impact on pay for bankers in the UK.
When this proposal was first debated, the lobbyists we spoke to felt that it would be unlikely to succeed as it would have such a negative impact on the EU’s banking sector. However, the mood changed over the summer as lobbyists began to realize that very few were prepared to defend bankers pay at a political level. In terms of where other EU countries stand, France is supportive of the proposal, Spain and Italy are unlikely to go against the proposal and Germany is heading towards an election and is therefore unlikely to want to lose political points supporting bankers pay.
In the event that the vote passes in a few weeks’ time, the cap on variable pay will be included in the European Union’s CRD4 legislation. In theory, this will come into force on January 1st 2013 – although it may well be delayed.
Why is the European Union persisting with caps on pay? There is a feeling that the existing remuneration requirements imposed under CRD3 legislation on January 1st 2011 didn’t go far enough. These specified that a proportion of pay had to be deferred, but left it to firms themselves to set an appropriate ratio of fixed to variable pay. However, when the European Banking Authority surveyed firms earlier this year, it found that variable pay was 429% of salaries for bank executives and 940% for material risk takers. This was considered high.
The likely impact of any cap on variable pay is that base pay will increase significantly. Fix costs will therefore increase, and pay will be far less related to performance. There is also a concern that bankers will move to jurisdictions such as the U.S. and Hong Kong where no such caps are in place.
At this stage, some things remain unclear. Will the cap apply only to material risk takers, or to all the staff in a bank? There is also the question of whether a similar rule will be adopted in other EU legislation to cover the hedge fund industry – and the insurance sector?
It remains possible that the cap will be watered down. Rather than forcing an absolute cap of one times salary, the EU may give shareholders the power to decide on a more appropriate level, or even to remove the cap entirely.
Any cap, however, is likely to lead to a significant change in the way banks pay their staff. We expect a rise in bankers’ salaries and further redundancies.
Alex Beidas is Linklaters’ employee incentives managing associate.